Updates on the FASB Reform for CECL
The Financial Accounting Standards Board’s (FASB) April announcement provided an update on plans for one of the most radical accounting reforms ever imposed on US-held financial assets – Current Expected Credit Loss (CECL).
The final Accounting Standards Update (ASU) on CECL will be published this month, after years of deliberations. It will require institutions for the first time to predict long-term debt-service performances on most of the private obligations they own. While numerous industries will be affected, the changes will most significantly affect longstanding banking and credit union practices.
Banking and credit unions will be severely affected by the new changes. They will require collecting huge amounts of new data, testing the data and building the systems required for implementation, and will likely cause a huge strain on resources. The announcement in April even deferred effective dates for CECL back a full year for these two industries because compliance will require such a large change in processes. Affected companies will need to start implementing processes for CECL soon in order to meet the deadline for reporting in 2020.
Three Major Changes under CECL
What will firms be expected to provide going forward?
- Radical changes to accounting practices: FASB's new CECL Standard, to be finalized this month, upends generations of familiar accounting practice in financial assets, most especially for banks and credit unions.
- New forward-looking view of financial performance: CECL will require lenders to discard their traditional impairment orientation towards underperforming borrowers and replace it with a forward-looking orientation towards all borrowers -- by making initial and recurring judgments of Expected Loss over the life of the individual obligation and/or the pool of similar obligations.
- Major challenges to meeting compliance: Compliance with CECL will demand data collection, analysis, retention and audit-readiness, along with methodology validation, on a scale vastly enlarged from all previous experience -- challenging the largest financial institutions and overwhelming their smaller, less-equipped counterparts.
Challenges CECL will Create for Firms
Loss estimations using the new model will immediately affect an institution’s Allowances for Loan and Lease Losses (ALLL) and other equivalent reserve accounts. The US Office of the Comptroller of the Currency (OCC) predicts increases of 30-50% for ALLL. With the prospect of such large increases, bankers worry that CECL will damage industry profitability, loan growth, and therefore general economic health.
The new CECL model demands a tsunami of new data collection, integration into their existing systems, and storage. Once the data is actually available, firms will also need to analyze results, validate accuracy, and make sure observations and calculations are audit-ready. FASB has appointed a 16-person group to advise on implementation of the new standard - the Transition Resources Group for Credit Losses (TRG). Members represent large banks, community banks, credit unions, audit/advisory firms and the SEC, along with a rotation of five other federal agencies. They will identify potential implementation issues for FASB’s benefit and act as a liaison among FASB and stakeholders learning what they need about the new standards.
CECL compliance will strain resources everywhere. Large institutions will be challenged by the increased demands, but smaller firms will suffer the most. Small institutions typically lack the staffing, budget and risk-management culture to truly implement these new measures. Firms that have sufficient resources internally may choose to complete this process in-house; however, many will need to look for external solutions to ease the burden of the new regulations.
Leveraging Technology to Meet Compliance Requirement
The most critical element in the CECL calculation, Estimated Probabilities of Default (EPD), is part of RapidRatings’ expanded offering that was introduced last year. Clients have access to the predictive and historical information that is essential for their reporting on tens of thousands of corporate names.